Dell’s Growth Slump Shows Urgency of Silver Lake Buyout

Dell Inc. (DELL)’s board is predicting
another year of lackluster growth in fiscal 2014 as demand for
personal computers ebbs, underscoring the urgency behind the
company’s decision to be taken private, documents show.

Sales for the year ending in January will slip to $56.5
billion, and Dell’s PC business will shrink by $10 billion over
four years, according to projections in a proxy statement filed
yesterday with regulators. Operating income will be stagnant at
$3 billion, according to the documents, which shed light on a
$24.4 billion buyout proposal led by Silver Lake Management LLC,
as well as plans by Chief Executive Officer Michael Dell to
accelerate a turnaround after going private.

The documents outline a worsening outlook for Round Rock,
Texas-based Dell that set the stage for negotiations -- kicked
off in June by shareholder Southeastern Asset Management Inc. --
that included company executives, a special committee of the
board, Silver Lake and their respective financial and legal
advisers. Dell is considering the resulting $13.65-a-share bid
alongside competing offers from Blackstone Group LP (BX) and
billionaire Carl Icahn that it says could prove superior.

CEO Dell told his board that going private would be the
best course of action because it would let him boost spending on
acquisitions, sales staff and research and development, while
investing in PCs and tablets and expanding Dell’s reach in
emerging countries, according to the filing with the U.S.
Securities and Exchange Commission.

5-Cent Standoff

Undertaking those investments while trading on public
markets would be “poorly received” by investors since they
would “weaken earnings and cause greater volatility” in the
stock price, Dell told the board during a presentation
in December.

The documents also lend insight into the sometimes
contentious negotiations between Dell’s representatives and
private-equity firm Silver Lake, which came close to walking
away from the deal in January, as well as a stalemate that
wasn’t resolved until Silver Lake upped its final offer by 5
cents a share at the eleventh hour -- ultimately boosting the
bid 22 percent from $11.22 at the outset.

CEO Dell sought to take his company private as slumping
demand for computers and accelerating competition eroded sales
and hammered the stock. Dell, who founded the company in a
college dorm room in 1984, is betting that he can enact a
turnaround more swiftly outside the glare of the public markets.
Dell and Silver Lake may need to sweeten their offer as
Blackstone and Icahn work to line up the financing required by
their respective proposals, which were submitted during a so-
called go-shop period that ended just after midnight March 23.

Blackstone, Icahn

Blackstone’s plan values Dell at more than $14.25 a share,
while Icahn would pay $15 a share in cash for as much as 58.1
percent of the stock, Dell said March 25. Under both plans, some
shares may continue to be publicly traded.

Dell met with Blackstone this week to discuss the company’s
proposal, people with knowledge of the matter have said. The
executive deems Blackstone’s offer management-friendly, one of
the people has said. Blackstone is open to keeping Dell on as
CEO, another person said.

Hewlett-Packard Co. and Lenovo Group Ltd. also scanned
Dell’s books during the go-shop period, people with knowledge of
the matter have said.

Dell fell less than 1 percent to $14.33 at the close in New
York on March 28, 5 percent above Michael Dell’s offer. U.S.
markets were closed March 29.

Southeastern’s Suggestion

The idea of an LBO was first suggested by Southeastern,
Dell’s largest outside shareholder, on June 15, according to the
filing. Southeastern proposed participating in a deal by rolling
some of its shares into the company. CEO Dell said he would
consider it. Southeastern now opposes the Silver Lake deal,
saying it undervalues Dell.

On July 17, Michael Dell met a representative of Silver
Lake at the Fortune Brainstorm technology conference in Aspen,
Colorado, and they arranged to meet again in August.

In mid-August Dell told Alex Mandl, the company’s lead
independent director, that he was interested in possibly taking
the company private and asked for information to study the
feasibility of a leveraged buyout. The board was open to the
idea. In late August, the company reported revenue of $14.5
billion, about $800 million less than the board had forecast in
June and $300 million below a revised outlook.

First Bid

By the end of the month, the board had retained law firm
Debevoise & Plimpton LLP and JPMorgan Chase & Co. as its
advisers, and by early September, the company had entered into
confidentiality agreements with Dell, Silver Lake and a second
private equity firm identified only as “Sponsor A.” That firm
is KKR & Co., according to a person with knowledge of the
matter.

The month following the earnings disappointment, the
company revised its outlook due to shrinking customer demand and
margins, changes in the PC market and greater competition.

On Oct. 23, when Dell’s share price closed at $9.35, Silver
Lake and KKR submitted preliminary, non-binding proposals to
acquire the company. Silver Lake bid $11.22-$12.16 a share for
all stock excluding that of Michael Dell, whose collaboration
was a condition of the offer. Sponsor A bid $12-$13 for all
shares except Dell’s and Southeastern’s, and suggested an
additional $500 million investment on Michael Dell’s part.

On Nov. 15, Dell reported quarterly earnings that missed
analysts’ expectations and its own guidance again, causing its
shares to fall about 7.3 percent to a three-year low of $8.86.
By then, it had hired Goldman Sachs Group Inc. and Boston
Consulting Group Inc. as advisers.

Sponsor A

Boston’s research would later underscore the decline in
Dell’s business. The division that includes PCs would decline by
as much as $10 billion in four years, Boston predicted.
Acquisitions “had yielded far lower returns” than management
had expected, the firm said.

Also in November, Silver Lake and Sponsor A submitted
revised bids, and on Nov. 30, Dell expressed his enthusiasm for
an LBO to the board, saying he could “supply as much additional
equity as might be needed for a transaction.”

On Dec. 3, Goldman Sachs analysts wrote a report suggesting
that Dell might be the target of an LBO, sending the company’s
shares up 4.4 percent to $10.06. That same day, Sponsor A
withdrew from the process, later citing the uncertain market for
personal computers and competitive pressures on Dell for its
decision.

The following day, Silver Lake submitted a revised bid of
$12.70 per share.

Microsoft’s Financing

On Dec. 6, Michael Dell told the board he thought that his
plans to invest in research, development and M&A, as well as
expanding the company’s sales staff and emerging markets
operations, would be better undertaken as a private company than
as a listed one.

“Mr. Dell reiterated his belief that implementing such
initiatives would require additional investments that could
weaken earnings and cause greater volatility in the performance
of the common stock,” according to the filing.

On Dec. 10, the board told Silver Lake any bid would have
to be significantly higher. At that point, Silver Lake said it
would need to seek financing from Microsoft Corp. (MSFT) That month,
private-equity firm TPG Capital -- identified in the proxy only
as Sponsor B -- also signed a confidentiality agreement with
Dell, a person with knowledge of the matter said.

On Jan. 16, two days after Bloomberg News first reported
that Dell was in buyout talks, Silver Lake submitted a bid of
$12.90 per share, backed by commitments from Barclays Plc, Bank
of America Corp., Royal Bank of Canada and Credit Suisse Group
AG, as well as $2 billion from Microsoft.

General Electric

The board balked at the price, and said it would support a
bid of $13.75 per share. Silver Lake responded that it could
offer no more than $13.25, though it raised that to $13.50 later
in January. Dell lowered the valuation of his rollover shares to
$13.36 so that Silver Lake could raise its bid to $13.60.

On January 24, Dell advisers received calls from
Blackstone, Southeastern and a so-called Strategic Party A
expressing interest in all or part of the company. The
unidentified party is General Electric Co., which sought Dell’s
financial services division, a person with knowledge of the
matter said.

Silver Lake raised its bid to $13.65 per share on Feb. 4.
After meeting throughout the day, Dell’s board finalized the
merger agreement, which included a go-shop period, and announced
its plans the next morning.

67 Parties

During the go-shop process, Evercore Partners Inc.
contacted 67 parties, including 19 potential strategic bidders,
18 financial sponsors and 30 others, including sovereign wealth
funds. Four others expressed interest unsolicited. Altogether,
11 parties were open to a transaction, but only three -- Icahn,
Blackstone and Strategic Party A -- submitted proposals by the
end of the go-shop process on March 23. Two days later, the
board said in a press release that it would continue to support
the merger agreement with Silver Lake while continuing
negotiations with Blackstone and Icahn.

Michael Dell’s employment agreement with the Silver Lake
group entails a stock-option grant with an aggregate exercise
price of $150 million. The company didn’t give an estimate of
the value of those options, which have a 10-year term. The
company estimated last year that a 2011 10-year option grant to
Dell was worth about one-third of the options’ exercise price.
Applying that ratio to the Silver Lake award would value it at
about $50 million.

Francisco, Insight

Michael Dell has agreed to forfeit the options he currently
owns in the company. The Silver Lake group may strike employment
agreements with the company’s other top executives and let them
invest in the new company, according to the filing.

Blackstone is proposing a leveraged recapitalization
transaction whereby investors could choose to get either all
cash or equity, subject to a cap, if they want to stay invested
in Dell. The shares would continue to be publicly traded.

The private equity firm, which has teamed with San
Francisco-based buyout shop Francisco Partners and New York-
based venture firm Insight Venture Partners, said it plans to
fund the transaction with a combination of equity and debt, in
addition to Dell’s cash and equivalents. Blackstone said it held
discussions with some of Dell’s largest shareholders and plans
to invite them to join the transaction.

Icahn is offering shareholders the option to roll over
their stakes or receive $15 a share in cash, with the amount of
cash limited to $15.65 billion, according to the statement.
Icahn has enlisted Jefferies LLC to conduct due diligence.

Icahn’s offer assumes that Southeastern and T. Rowe Price
Group Inc., the largest Dell investors after Michael Dell, would
contribute their stakes and won’t receive a cash payment.